Contracts Quiz: Eternal Obligation?

You’re a franchisor and the term of your franchise agreement is five years, but you can terminate it early for cause. The term and termination provision also auto-renews. Do you have the right to elect not to renew the agreement at the end of the initial term or a renewal term? Or are you on the hook for ever if the franchisee doesn’t give you an out by materially breaching the agreement?

To help you analyze the issue, here’s the first part of the term and termination provision: “The initial term of this Agreement shall begin on the date hereof and, unless sooner terminated by [the franchisor for cause] as provided in paragraph 6, shall end five years after such date, and shall automatically renew itself for successive five-year terms thereafter (the ‘renewal terms’).”

I’d say that the franchisor has the right to elect not to renew the agreement. I’d say that the franchisor also has the right to terminate early if the franchisee materially breaches. Of course, the franchisor would have to give plenty of notice if it elected non-renewal, both because it’s required to act reasonably and because courts and legislatures are solicitous of franchisees. But termination by non-renewal seems to be a no-brainer to me.

Would your answer change if the same term and termination clause contained a proviso that allowed the franchisee to terminate the agreement at the end of the initial term or a renewal term? Here’s the language from the contract: “provided, that Franchisee may terminate this Agreement effective at the end of the initial term or any renewal term upon at least 120 days written notice to Block prior to the end of the initial term or renewal term, as the case may be.”

If you answered that the franchisor isn’t on the hook for ever, you have the backing of the Eighth Circuit, but the dissenting judge and the U.S. District Court for the Western District of Missouri would beg to differ.

The term and termination clause

The initial term of this Agreement shall begin on the date hereof and, unless sooner terminated by Block [for cause] as provided in paragraph 6, shall end five years after such date, and shall automatically renew itself for successive five-year terms thereafter (the “renewal terms”); provided, that Franchisee may terminate this Agreement effective at the end of the initial term or any renewal term upon at least 120 days written notice to Block prior to the end of the initial term or renewal term, as the case may be.

Perpetual agreements don’t get a lotta love

To analyze the issue, you have to keep in mind that courts don’t exactly love perpetual agreements. According to the District Court, “Missouri courts generally do not favor perpetual contracts. However, they will enforce perpetual contracts where the terms of the contract expressly state or clearly implicate that the parties intended the contract to be perpetual.” [citations omitted]

The Eighth Circuit expanded on this rule in its opinion:

Missouri courts are prone to hold against the theory that a contract confers a perpetuity of right or imposes a perpetuity of obligation. The [Missouri] Supreme Court has made clear that, to be enforceable, a contract which purports to run in perpetuity must be adamantly clear that this is the parties’ intent. Missouri courts will only construe a contract to impose an obligation in perpetuity when the language of the agreement compels that construction, such that the parties’ intention that the contract’s duration is for life … is clearly expressed in unequivocal terms. [citations and internal quotations omitted]

Drafting and interpreting term and termination provisions

So does the term and termination clause in H & R Block compel the construction that the parties intended a perpetual agreement? Is it “adamantly clear”?

Having recently re-read Ken Adams’s Manual of Style for Contract Drafting, I can hear Ken’s criticism of the provision: “shall”? “hereof”? “such date”? “provided”? All sub-optimal. Plus, the language is just plain confusing. If the drafter intended for the agreement to be perpetual, he — or she — should have stated that clearly. If the agreement wasn’t meant to be perpetual, the drafter muddied the waters by mashing up the franchisor’s right to terminate for cause with the franchisee’s right of non-renewal by use of a proviso.

The language giving the franchisee the right not to renew the agreement by providing 120 days’ notice creates confusion. Does it imply that the franchisor doesn’t have that right? The natural reading of the clause absent the proviso would be that the franchisor could elect not to renew the agreement. But if that right were implied, wouldn’t the proviso be meaningless, thus implying that the franchisor didn’t in fact have a right to elect non-renewal?

Either way, the language is confusing, and the parties needed a court to resolve the conflict.

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Brian, I agree with you. If I were advising a franchisor in this situation under English law, two practical issues to consider would be (a) when should the franchisor terminate, ie at any time or only at the end of a 5 year term, and (b) how much notice should be given. Taking a cautious line, I would probably have advised the franchisor to terminate at the end of a 5 year term, and to give enough notice to allow the franchisee a reasonable time to establish an alternative business. I would have asked the franchisor whether that might be, say, 12 months, 6 months or the 120 days’ notice that the franchisee has to give. 6 months in the context of a 5 year agreement feels about right, in the absence of any other information about the industry etc. So, subject to discussion with the client, I might well have come out with the choices that the franchisor made, ie 6 months notice to terminate at the end of a 5 year term.

Interesting post Brian. I agree with you as regards the outcome in the 8th circuit. It makes commercial sense. But I’m inclined to think that franchisor was a little bit lucky. There was clearly plenty of fun to be had on the franchisee’s side of the argument with a bunch of old latin maxims (expressio unius, contra proferentem et al) given the wording of the clause. I bet the modern version of these agreements expressly reserves franchisor’s right not to renew on notice & without cause (?)

Adrian: I believe several of H&R Block’s franchise agreements have been litigated over the years. It would be interesting to track the development of the language through time. But I wouldn’t be surprised to learn that the company failed use the lessons of litigation to improve its contracts. I believe it’s still common practice to use the ambiguous phrase “drilling or reworking operations” in oil leases, although it’s been the source of a lot of litigation throughout the country. (See my post about a 2011 Eighth Circuit case.)

I agree that the franchisor was a bit lucky. If you come out on top when rules of construction have made an appearance, you should consider yourself lucky.

There was plenty of fun to be had for sure. Thoroughly analyzing the issues would require a lot of brain cells.